Briefing Book: Iran’s Sanctions

With negotiations over Iranian uranium enrichment floundering, both sides are looking at plan B. Despite Barack Obama’s stated goal of engagement, harsh new sanctions are seeming likelier by the day, with the U.S. Congress already approving legislation that would prohibit petroleum companies that work with Iran from doing business in the United States, and intensive negotiations already underway over what U.N. sanctions would look like.

Historically, Tehran has always responded to sanctions not by stopping the behavior engendering them, but by preparing for them — developing an autonomous Internet and producing military equipment domestically, for instance. It has spent the past two years developing a comprehensive plan to mitigate the effects of strengthened sanctions. It seeks to reduce domestic gasoline consumption, secure alternative gasoline import sources, and increase domestic production — eventually, boosting  indigenous capacity until Iran is self-sufficient.

Here, a briefing on what to look for if sanctions become reality.

Sanctions and gas: the basics

Iran has the third-largest proven petroleum reserves and the second-largest natural gas reserves in the world. But it is a net importer of gasoline because it does not have the refining capacity to meet its domestic demand, elevated due to generous government subsidies. And it has tapped just one percent of its compressed gas.

This makes Iran susceptible to sanctions on its energy supplies. Currently, the United States prohibits virtually all investment and trade activity with Iran, with exceptions for the import of food, Persian rugs, informational materials, and gifts valued under $100. U.S. laws, in concert with U.N. Security Council resolutions, also provide sanctions specifically targeting Iran’s nuclear and weapons proliferation, including access to financial markets supporting those activities.

In light of further sanctions on gasoline imports, the Iranian government plans to reduce consumption in five ways: increasing the price of gas, enforcing strict rations, decreasing government subsidies, developing alternative fuels, and improving public transportation. Tehran started to implement these measures in 2005 and has achieved limited success thus far.

In May 2007, the government enacted an unprecedented 25 percent increase in the price of gasoline. The next month, it implemented a national rationing scheme, limiting drivers to 100 liters (26.4 gallons) per month. It has varied the quota over time, from 75 liters per month to a high of 120 (it currently sits at 100 liters, at 10 cents per liter). Drivers can purchase gasoline above their quotas at a quadrupled price of 40 cents per liter.

Despite increased prices and stricter quotas, the government still spends nearly a third of its budget on gasoline subsidies. In 2008, President Mahmoud Ahmadinejad suggested reducing this burden by ending direct subsidies and giving low-income Iranians a stipend of $70 a month instead. The Iranian parliament did not pass the plan — and the subsidies remain in effect. Recently, the parliament reviewed the plan again and passed it on Oct. 18 (though the proposal must still be approved by the Guardian Council).

The government also subsidizes compressed natural gas (CNG), though this alternative fuel is vastly cheaper than gasoline — in Iran, it’s 250 liters to a penny. Given Iran’s vast reserves, CNG is a viable alternative energy source, but it isn’t easily used quite yet. As part of a national campaign to switch over to natural gas, Ahmadinejad passed a law in 2007 requiring carmakers to manufacture cars that run on both fuels. CNG now accounts for 10 percent of transportation fuel usage, and the government is opening 1,000 dual-use stations by the end of the year.

In addition, the government has examined expanding its public transportation systems. Iran, as a country, relies on its cars. Out of the 12 million inhabitants of Tehran, only 1.5 million use the subway every day — despite horrible traffic. In 2007, the parliament passed a public transportation bill designed to improve and expand subway, railway, and bus systems. But projects in Tehran and elsewhere are years behind schedule.

The plan approved on Oct. 18 seeks to expand upon and improve these measures in the face of possible further sanctions. Tehran plans to reduce gasoline quotas next spring and raise the price of fuel. Under the most likely plan, quotas would be reduced from 100 to 80 liters per month at an increased cost of 40 cents per liter. The price of gasoline above the quota level would increase to 65 cents per liter. The Iranian parliament is also considering giving subsidies to the two lowest income deciles only.

Self-sufficiency

Iran’s real plan is to become energy independent. To this end, it is expanding more than half of its refineries, and building seven more. One recent Iranian media report claimed that "nine refinery development projects" were "80 to 90 percent" complete. With this additional capacity, Iran’s import requirements are expected to drop by a quarter to a third this fall and a further 15 percent next year. Iran might actually export refined products in the next three to five years, according to Fars News.

Several things might hamper these efforts. Much of the refinery expansion depends on technology, knowledge, or patents from European companies, assets that may be unavailable — or more expensive — if the West enacts sanctions. China might be able to provide assistance, as it has expanded its own refineries on a large scale, but it might be deterred by countries like the United States. Moreover, the size of the investment required — billions of dollars for some projects — might cause further delays, particularly in light of potentially crippling economic sanctions.

However, the sheer volume of Iran’s capacity expansion means it will almost certainly become self-sufficient. Only 13.4 percent — 128,000 barrels per day — of the expansion and construction capacity needs to come online for Iran to meet its consumption needs.

Who might help Iran?

Although Western countries — especially the United States — look likely to enact sanctions, several countries will aid Iran by acting as alternative suppliers of oil. Venezuela has said it will provide Iran with 20,000 barrels more per day. But more than any other, China is the country Iran wants on its side.

Beijing currently ships around 30,000 barrels of gasoline a day to Iran, a sum it could triple without difficulty. Additionally, Chinese companies have worked on 11 Iranian development projects valued at more than $33 billion this year alone. These projects focus primarily on natural gas and oil extraction efforts in the Persian Gulf. Beijing prizes these projects because of the lucrative hazard fees Iranian companies pay Chinese companies to do business there.

Given its extensive economic involvement in Iran and its history of doing business with sanctioned countries (such as Sudan and North Korea), China might well step in to fill Iran’s 90,000 barrel per day demand gap if the sanctions fall.

The internal threat

But any measures Tehran might take to reduce domestic consumption and increase domestic production come with risks.

The 2007 rationing plan was a first step toward an energy-independent Iran. But domestic backlash against these initial measures has made Iranian officials wary of further action. Protesters set fire to at least 19 gasoline stations across the country, throwing stones and shouting anti-Ahmadinejad slogans. Demonstrators also attacked state-run banks and business centers. During clashes with anti-riot police, at least one woman was shot and killed.

If enacted, the current proposals might generate protests on a much larger scale. For one, the price rises would be much bigger, 300 percent versus 25 percent two years ago. This would add to the economic burden of ordinary Iranians, who already suffer from high housing prices and rising unemployment. Plus, historically, gasoline rationing has inflated the price of other goods and services. Just one day after the 2007 plan came into effect, for example, food prices and taxi fares swelled by double digits. According to the Parliament Research Center in Iran, the proposed bill would cause the inflation rate to jump to 48.6 percent, immediately hurting the standard of living and fueling popular anger.

Sparks of public outrage might ignite an already tense political atmosphere. In the wake of the disputed presidential election and controversial crackdowns, new provocations might empower regime opponents. Although the opposition movement has weakened since June’s massive post-election demonstrations, renewed protests at the Quds Day rally on Sept. 18 in Tehran and the anti-regime demonstrations on Nov. 4 — the anniversary of the 1979 Iranian takeover of the U.S. embassy — suggests that internal dissatisfaction persists.

Ironically, the group that should be the target of strengthened sanctions, the Islamic Revolutionary Guard Corps (IRGC) — a powerful military branch which controls numerous commodity and construction businesses — is least likely to be affected. Indeed, some analysts argue the IRGC benefits from an economically isolated Iran because it does not need to compete with foreign companies for government contracts. For example, one of the main engineering companies under IRGC control, Khatam al-Anbiya, has secured at least $7 billion in government oil, gas, and transportation deals in recent years — a figure that might rise with further sanctions.

Challenges for foreign governments

Implementing refined-petroleum sanctions poses challenges for international policymakers as well. For instance, if financiers or insurers of Iran’s petroleum industry curb their business due to the sanctions, less risk-adverse institutions might fill the vacuum. These second-tier financiers often do not require or desire access to U.S. markets and are therefore immune to the threat of U.S. sanctions.

Plus, unilateral U.S. sanctions targeting Iran’s refined-petroleum imports might not be enough of an impetus for firms to curb their gasoline exports to Iran. An official from the French firm Total, a major gasoline exporter to Iran, recently indicated that the firm would adhere to bans on petroleum export to Iran if such laws were passed in both the United States and Europe. But other firms have hedged. The potential effectiveness of U.S. legislation in persuading firms to comply might depend on European acquiescence; more so, it might depend on China’s and Russia’s willingness to break with history and support the measures.

Ultimately, it is not possible to predict with certainty what effect the sanctions under consideration will have on the Iranian economy, let alone on the regime’s behavior. It is clear that the regime has already taken into account the possibility of such sanctions and has developed a plan it may think will circumvent them. If the regime has confidence in its plan — however realistic it might or might not be — then the imposition of sanctions might generate no significant change in Iranian policy in the short term.